| The pattern of belief | |
| Mukul Pal / New Delhi June 22, 2009, 0:15 IST | |
Human emotions are as measurable as prices. The challenge is documenting an emotional time series.
The first week of June, I transformed myself into a movie buff starting with the ‘Man on Wire’ an Academy Award-winning 2008 documentary film directed by James Marsh. The film chronicles Philippe Petit’s 1974 high-wire walk between the Twin Towers of New York’s World Trade Center. Another film was ‘Gabhricha Paus’, The Damned Rain, by Prashant Pethe is about the plight of cotton farmers. The Indian film completed a cycle for me, as it connected me back to an article ‘Who is killing the cotton farmers?’ I wrote here on February 5, 2007. This connected me back to psychology, prediction, philosophy and time. The reality of rain for a farmer is harsh, but it can just be a mood spoiler for the city man.
Human mood is shocking and beautiful at the same moment. Despite this diversity and contrast, does this mood have a form? Is belief patterned? Does emotion have self similarity? Water is the similar aspect but has different meanings or different interpretations as settings change. How different are interpretations anyway?
Let us say a farmer and a trader. There is a human anticipation (for rain or for news), there is debt (farm land or house mortgage), there is prediction (regarding rains or markets), there is unrelentless speculation and hope (things would be different this time), there is a risk and return (correct or incorrect) in both cases and there is an inertia to hold on to the status-quo. The farmer can’t stop farming and so can’t the trader resist the lure of a trade. We are tied to our vocations, different occupations, interpretations but with a similar emotional frame.
The emotions link
Was it really the rain that killed the farmer? There is a more than a decade long secular negativity on cotton. There was no mention about the cotton prices in the film. Why? Because the reference frames explore emotions. So whom do we blame for a life lost, it was not the cotton price nor the rain. It was the emotional drift. Human inability to detach, to stop, to pause, not to trade, to take a vacation, to not go to work one day (you should see the film). It’s not that we are mechanical. It’s that we drift.
Reacting to news
Behavioural finance also refers to a similar psychological tendency as drift. In his survey of the literature on post earnings announcement drift, Bernard (1993) discusses evidence concerning market prices under-reaction to analyst forecasts. He explains that the post announcement stock prices for firms that have reported “good news” tend to drift up, whereas the prices for firms that have reported “bad news” tend to drift down. It pays to hold stocks that have experienced recent large positive earnings surprises, because the market does not fully adjust to the good news.
This same under-reaction or overreaction of prices is later ascribed to analyst behaviour. Behavioural finance does not make an attempt to differentiate under-reaction or overreaction in prices from that witnessed in analyst behaviour. The subject also talks about two types of investment approach viz. momentum and reversal (contrarian) approach. Momentum approach is nothing but herding approach, more common and comfortable owing to the sentiment drift. So what overreacts, prices or people or both?
Status quo
Inability to book a loss or procrastination can be associated with the drifting sentiment. The other behavioural ideas like extrapolation bias, psychological herding are an extension of this drift. When people get together, group thinking takes over and the group is assumed to think right, this is why herding (drifting) becomes natural.
Technical analysts have also unknowingly handled the idea of drift. Why do bear markets have two stages of fall? Why do markets extend? Is this not because the sentiment has inertia, it cannot just stop after a deep crash, it needs time to reflect, make up its mind. Where did the frog in the well come from? It came from our need for the status-quo. We love the proverbial well.
Sentiment cylicality
Any questions regarding dynamic sentiment or drifting sentiment can be put to rest if one associates drift with pulse or life. If mood is such an important driver for economic trend then it’s got to be moving and not static. Now if we have come to terms that sentiment moves, how can we start quantifying it? Sentiment surveys are trashed by behavioural finance, but not even one behaviourologist talks about the cyclicality in sentiment surveys. The bullish percent readings move from one extreme to the other in a banded (0 – 100 per cent) fashion.
Now one may ask what has belief, fear, greed, panic got to do with sentiment readings? Well the readings are only expressing the degree of belief or greed in market on the positive extreme and degree of fear and panic or the lower extreme. The cyclicality of sentiment can be observed across time frames, one minute to multiple years, people (traders) will move from euphoria to complacency (passiveness) on all time degrees. Time translation (earlier feature) not only connects the bell curve (efficient school) with the Pareto curve (inefficient school), but also is the underlying force that drives and defines mood.
Classifying mood
The human mood drifts because of time and assumes the pattern of time, the pattern of time triads and triangle in a triangle. Robert Prechter’s Socionomics was the first subject which ever attempted to classify mood. In 2002, Prechter said that he expected it to take another ten years to construct a full theory of the components, aspects, processes and structure of social mood.
Socionomics demonstrates the social mood trend, which we are labelling as drift. Prechter accepted that component work was more of observational summaries and not a hypothesis. For us at Orpheus, human emotions are measurable and mathematical just like price, it is just that quantifying mood for one minute time frames is a cumbersome process, as the trader is busy trading rather than filling sentiment surveys regarding how he feels at that moment.
Mood patterns
Socionomics suggests that there appears to be a social polarity that underlies all social interaction. Prechter refers to these opposites as “positive” and “negative”, which according to us are the polarity of time reflecting in the mood. He illustrates two poles of social mood viz. confidence/fear, constructiveness/destructiveness, happiness/unhappiness etc.
In his book ‘The wave principle of human social behaviour’, Prechter details a thorough classification of changing moods causing changing prices or changing trends. The guru admits that his observations could be used to probabilistically predict social mood, but he does not suggest that mood could itself be a self similar fractal and measurable as a Pareto power law curve. Prechter has demonstrated smaller aggregations to suggest mood expressing a fractal form, but he still admits that his classification of moods is roughly representative, not precise or conclusive. Understanding time fractals simplifies many challenges linked with quantifying mood.
A human mood doesn’t need a language to communicate. The society mood is interwoven in time and time translates and moves giving a pulse to social mood like it pulses everything else. Even if we communicate or miscommunicate, the polarity of mood is a universal mathematical truth owing to the underlying time.
The best traders I have met question their own emotions. It’s just like Philippe Petit the man on the wire told himself, “it cannot be done”. It was only when the dream of tightrope walking the twin towers was improbable that the hurdle could be overcome. This is how celebrated individualism comprehends the pattern of belief.
The author is CEO, Orpheus CAPITALS, a global alternative research firm
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